Black Sky Capital v. Cobb — Is the Merger Rule in Jeopardy?

keith dunnagan lawyerToday, we take a look at the Merger Rule and a case that is working its way through the California Supreme Court. The Merger Rule provided significant relief for borrowers during the Great Recession, but whether it remains a viable defense for borrowers is in question.

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Today, we take a look at the Black Sky Capital v. Cobb (“Black Sky”) case that is currently pending before the California Supreme Court. This case in its current form could change the course of court rulings related to foreclosures and deficiency rulings and if the law changes it could create a significant harm to consumers. For more than 60 years, California has maintained a strong policy restricting the ability of lenders to pursue borrower’s for deficiency judgment following a foreclosure. This policy started with the adoption of California Codes of Civil Procedure 580b and 580d. CCP 580b restricted the lender’s right to seek deficiency judgments related to purchase money loans on 1-4 unit residential dwellings. CCP 580d provided that a lender could not pursue a deficiency judgment following a foreclosure through the power of sale process (a non-judicial foreclosure).


However, it wasn’t long before lenders began to get creative with financing mechanisms to get around these statutes. Lenders started using junior lien models to allow a foreclosure on the first while at the same time preserving what would become an unsecured junior lien in the second position to bring an action against the borrower for monetary relief. It was out of this successive securitization that the concept of the Merger Rule was developed at the common law. In 1976 in the Union Bank v. Wendland case decided the by the First District Court of Appeal stated that “A ‘merger’ occurs when a greater estate and a lesser coincide in the same person in one and the same right without any intermediate estate.” What this means in English is that when a lender has two liens back to back (ie a First and a Second) if a lender forecloses on the first the law treats the two loans as having been merged into one loan.

As the Court went on to state, it was concerned with lenders using multiple liens whether issued at the same time or not as a means to get around California’s policy against deficiency judgments. Further, the Court went on to state that if the result of multiple liens on a property over-secures the property, that is there is insufficient value in the property to provide adequate security, the risk of that over-securitization should fall to the lender, as it is the lender who is in the best position to determine its risk tolerance and securitization needs. The decision was later upheld and supported by the Simon v. Superior Court decision in 1992. For more than 40 years, the merger has been the law of land.

It now seems as though this common law decision may be in jeopardy. In 2017 the “Merger Rule” took a hit in the Black Sky case decided in California’s Fourth District Court of Appeal. In this case, the lender made two loans a couple years apart for significant sums of money secured by one commercial property. Some seven years after the second loan was made, the borrower found itself in default. The lender completed a non-judicial foreclosure on the first deed of trust thereby wiping out the security on the second note. Thereafter, lender brought an action to recover on the second note as an unsecured creditor seeking a money judgment for the unpaid loan. Under the Union Bank and Simon decisions, such action would fall squarely within the “merger doctrine” and the subsequent action by the foreclosing lender to recover under its second position loan would be unsuccessful. The Cobbs as the borrower’s in this matter, brought a motion for summary judgment and the trial court in reliance on the Simon ruled in the Cobbs favor that CCP 580d did, in fact, prohibit the action by the foreclosing lender on the second note. However, upon appeal the reviewing court in reliance on the Roseleaf Corp. v. Chierighino decision reversed the trial court. The reviewing court was stuck on the policy of the Roseleaf decision that states that “The junior’s right to recover should not be controlled by the whim of the senior, and there is no reason to extend the language of section 580d to reach that result.”

It appears that the reviewing court may have missed the point. The law does not support any contention where a second lender would cutoff from pursuing a judgment on its own sold-out lien when a different first lender completes a foreclosure. What the merger doctrine prohibits in its very limited application is the situation where a first lender gets the benefit of a foreclosure on a property then seeks additional recovery on a subsequent junior lien. The lender in foreclosing received all of the benefit of its collateral. The risk of over-securing collateral falls to the lender taking security.

However, in the wake of Black Sky that may no longer be the case. It may now be that a lender with successive loans can take the entirety of the benefit of the collateral and then seek additional recovery on sold-out junior positions. Time will tell for sure. The Cobbs appealed the decision to the California Supreme Court and considering the conflict in the districts, the Supreme Court granted cert and will decide this issue. In the meantime, the “Merger Rule” is in a state of uncertainty.


The attorneys of BPE Law Group, PC. have been advising our clients on real estate, business, and estate planning issues for over 20 years and have assisted numerous clients in business and real estate matters and have represented clients in hundreds of matters involving secured transactions. If you have questions concerning legal matters, give us a call at (916) 966-2260 or e-mail Keith at Our flat fee consults for new clients may get you the answers you need for the questions you have.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are facing a legal issue of any kind, get competent legal advice in your State immediately so that you can determine your best options.